Mutual Funds: Time to Switch to Growth?

June 20, 2002

In the world of mutual funds, it may be time to turn again to growth funds, according to Philip Edwards, managing director of Standard & Poor's Select Funds Group. However, in terms of current performance, small- and midcap value funds have been doing the best, Edwards says, although growth funds in those capitalization areas tend to lead the way out of a recession.

Analysts at S&P Select Funds winnow 35 funds out of the 10,000-plus on the retail market. Their decisions are based on performance -- and especially on quality of management. Edwards says that, over the last three years, the 35 have in general beaten their peers.

Among the specific growth funds Edwards cites are Harbor Capital Appreciation in the large-cap area and Turner Midcap Growth. He also suggests that index funds could be a good buy, but also recommends separately picking up small-, mid-, and large-cap index funds to balance a portfolio.

Edwards made these comments in the course of a chat presented June 18 by BusinessWeek Online and Standard & Poor's on America Online, in replying to questions from the audience and BW Online's Jack Dierdorff. Following are edited excerpts from this chat. A full transcript is available on AOL at keyword: BW Talk.

Q: Phil, before we dig into the funds, are you relieved to see the overall market turn in two days of better performance?

A: I don't think it's time to call the turn yet. The market is still lacking a lot of confidence and may continue to slide sideways for some time.

Q: And how about mutual funds, as we near the end of the first half? What have been the best and worst types this year so far?

A: The performance continues to be very mixed. The small- and midcap value sectors are the only ones that are showing any signs of life.

Q: Recommendation for a long-term 401(k) for a 30-year-old?

A: I think that a mix of equities, including mid- and small-cap equities, would be prudent. Some small exposure to the international market would add some diversity as well.

Q: What do you think of DODGX

(Dodge & Cox Stock Fund)?

A: Excellent fund. It is managed by a very experienced team and has a very impressive track record. It handily beat the S&P 500 over 5- and 10-year periods.

Q: Will technology mutuals come back -- if so, when? Any feelings on ATEYX

(Alliance Technology Adv)?

A: I would only use technology at the very edge of the portfolio, and I would not have it as a core holding. I don't think technology will ever be what it was. The Alliance Technology Fund looks like many of the others, no better or worse.

Q: What's your opinion on investing in small-cap index funds at this time?

A: Small- and midcap growth stocks usually lead the way out of a recession. So it may be a good time to look at small- and midcap indexes.

Q: What in your opinion is the mutual fund to hold long-term in technology? If any, based on what you said a minute ago.

A: I don't have a specific recommendation for a technology fund. I would rather be exposed to a growth fund that includes technology.

Q: Before we go further, Phil, brief us on S&P's Select Funds and the way it works in rating funds.

A: We have identified 35 funds that meet our criteria for consistency of performance and quality of management. And this list is available at www.standardandpoors.com.

Q: And what are S&P's criteria for selecting Select Funds?

A: Each of the Select Funds meets our rigorous standards for performance, as well as management. Importantly, we combine both aspects before coming to a conclusion. In a nutshell, we have to have a great deal of confidence in the management before we'll even consider the funds for the list.

Q: Phil, is any type of fund or fund family represented more than others among the 35 in Select Funds?

A: American funds are well represented, as well as ABN AMRO funds.

Q: So do you plan to keep the list at 35 funds?

A: In that range, yes. People don't need hundreds of funds in order to have a diversified portfolio.

Q: Have you had enough experience to compare the performance of the Select 35 over time with broader fund measures?

A: Yes. Over the last three years, the 35 have in general beaten their peers. However, in extreme markets, such as '98 and '99, they sell below their peers because we don't typically choose concentrated funds that do well in those conditions.

Q: Which specific funds do you recommend for a conservative retiree portfolio, whether managed or index funds?

A: I would say you want to go with some large-cap value funds, such as Vanguard Windsor II (VWNFX) and a bond fund such as Legg Mason Investment Grade (LMIGX).

Q: At the other extreme of time horizons -- I have some money to invest long-term for my children. Where should I put it?

A: I would allocate a portion of it to the S&P 500 index, and also a portion to an actively managed midcap fund and a small-cap fund, such as Baron Growth (BGRFX) and T. Rowe Price Mid-Cap Growth (RPMGX).

Q: Is the Vanguard Precious Metals Fund (VGPMX) a good selection, pending the possibility of inflation coming back?

A: Gold has done very well, but I'm not sure anybody is forecasting much inflation on the horizon. However, at the edge of the portfolio, this may be a good investment to diversify your holdings.

Q: Are there any specific growth funds that you would recommend for these times?

A: A large-cap growth fund, Harbor Capital Appreciation (HACAX) is a very good fund, as well as Turner Midcap Growth Fund (TMGFX).

Q: You mentioned early on that small- and midcap funds have done best so far this year. Any funds in those categories on S&P's Select Funds list?

Q: My broker is recommending several intermediate bond funds, including PIMCO Total Return D. Is that consistent with a recommendation to move away from long-term bonds?

A: It depends on your investment horizon. In a period of rising interest rates, which we're expecting over the next 24 months, intermediate and long-term bond funds tend to lose value. If your investment horizon is long-term, the Total Return Fund is a great option. However, in the short term, it may suffer.

Q: Any better return than money market for a one-year horizon and safety of principal?

A: There are stable value funds available. They provide higher than money-market returns, with almost the same certainty of return of principal. I believe that Dreyfus offers one.

Q: Your thoughts on One Group Investor Growth & Income (ONGIX) or One Group Equity Index (OGEAX)?

A: The Investor Growth & Income Fund is good, but not great. It appears to invest in other One Group funds. I would prefer to invest directly in the underlying funds. It's tough to beat Vanguard for index funds. For example, the expense ratio on the One Group Equity Index fund is 0.6%, and on the equivalent Vanguard fund, it's 0.18%.

Q: What are your opinions of Davis Financial (RPFGX) and Davis New York Venture (NYVTX)?

A: Both are great funds, especially since financials are the Davis family specialty. I think both are great investment opportunities.

Q: Are they on the S&P list?

A: Not at this point. Our list is intentionally small, and there are a lot of good funds that don't have the opportunity to make our list.

Q: One question submitted this afternoon suggested a misunderstanding that Select Funds was a fund family. It's S&P's objective ranking of mutual funds comparable to its stock rankings you are probably familiar with -- the STARS list. Anything to add to that, Phil?

A: Yes, the Select funds are ones that S&P has chosen from the universe of 10,000-plus available to retail investors. They are chosen based on fundamental research from analysts that have an average of 10 years' experience in the industry.

Q: Among the Select Funds, what look like the best buying opportunities at current prices?

A: Any of the growth funds look pretty good at this point. As a matter of fact, it may be time to rebalance between value and growth.

Q: Can you refresh us on value and growth favorites?

A: In the large-cap area, the ABN AMRO Chicago Capital Growth (CHTIX) is a good fund. And as previously mentioned, Vanguard Windsor II (VWNFX) is a good large-cap value fund. In the small-cap arena, the Baron Growth Fund (BGRFX) and Third Avenue Fund (TAVFX) are good candidates for individuals' portfolios.

Q: Have mutual-fund investors been exhibiting the same nervousness we see in the stock market generally? Are sales down, redemptions up?

A: Inflows have slowed considerably but haven't turned negative. I think that reflects automatic investment into 401(k) plans and a long-term investment horizon by many individuals.